NASCON’s Unimpressive Revenue Impairs Bottom-Line Performance

Operating Challenges Weaken Revenue:NASCON Allied Industries Plc reported FY2018 revenue of NGN25.77bn, which represents a 4.78% decline from the NGN27.06bn recorded in the previous year. This was due to the weaker contribution from the sales of salt, which constitutes 80.57% of the company’s topline while its tomato processing and vegetable oil plants lay idle. However, the revenue from its seasoning products and freight business grew by 20.76% and 5.84% respectively, with the latter accounting for 15.85% of total revenue.

In 2019, production is set to resume on the company’s tomato processing plant following its strategic decision to focus on backward integration for the supply of raw materials, along with the resolution of its disagreement with local farmers over pricing of tomatoes. We also expect the company to benefit from the planned ban on the importation of tomato paste by the FG. However, the contribution from this business segment should be modest; the difficulty in stemming the inflow of smuggled products through the country’s porous
borders as well as anticipated shortfalls in supply as local farmers adapt to the improved seedlings to be supplied by NASCON. Hence, we estimate revenue to grow by 5.0% to NGN27.05bn by FY2019. The company’s backward integration plan for the vegetable oil segment has a longer gestation period and is not expected to add to revenue in 2019.

Sticky Costs Structure Impairs Profit Margins: The decline in revenue pressured the gross margin, which contracted to 30.19% from 36.93% in FY2017, but this was worsened by the 5.38% rise in the cost of sales. Operating expenses also spiked by 13.48% to NGN2.70bn (vs. NGN2.38bn in 2017), the highest in a decade. Consequently, Profit before Tax and Profit after Tax dropped by 18.46% and 17.28% respectively. Net margin also declined by 3.20%, slightly underperforming a 5-year median of 16.30%.

Operating Accruals Underscores Poor Earnings Quality: NASCON generated NGN0.99bn in cash from its operating activities, barely 22.00% of its net income for the period. This underscores poor earnings quality for the year and raises the possibility of future negative earnings surprises.

Value Creation Constrained by Lower Asset Turnover: Return on equity dropped sharply from 50.95% in FY2017 to 33.51%, slightly below its five-year average of 35.59%. This was largely due to decreased asset utilization over the financial year, as asset turnover fell to 0.85x, lower than a seven-year average of 0.97x. Similarly, the return on asset weakened for the period at 12.97% (vs.16.56% in the previous year).

Recommendation: Our target price was reviewed downwards to NGN17.86
given lower expected EPS of NGN1.52 (vs. previous estimate of NGN2.19) and a
target PE of 11.75x. This gives a downside potential of 6.66% to its closing price
of NGN19.05 on the 16th of April. We therefore rate as HOLD.

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